Before Alex Kennberg and Joshua Moore came up with the idea to design and produce a sleek wallet which doubles as a smartphone stand, they already knew how they wanted to get it off the ground — crowdfunding.

The two former University of Waterloo students didn’t meet while at their alma mater, but were introduced last June by a mutual friend who knew of their shared entrepreneurial ambitions. Continue reading.

The Canada Revenue Agency has issued comments that indicate if a person gives funding towards a business venture, such as a musical recording, and receives a finished product or a promotional item — but not equity or a share of the profits — that money will be treated as business income and subject to tax.

The CRA’s comments released this week clarified a grey area for entrepreneurs, and is a stance which makes it more expensive to crowdfund a project.

This could significantly impact independent artists and start-up businesses who can’t access seed money in ways other than crowdfunding, said Ted Citrome, an associate in the tax group at Cassels Brock & Blackwell LLP.

“For profitable companies that are looking to crowdfunding as a way of funding a commerical venture, it will raise the cost of financing,” he said. “It will be more expensive for them to raise the funds.”

The CRA’s view on crowdfunding came to light in a technical interpretation, given in response to a query submitted earlier this year and released publicly last week.

“In our view, amounts received by a taxpayer from crowdfunding activities would generally be included in income pursuant to subsection 9(1) of the Act as income from carrying on a business,” wrote the CRA in the technical interpretation.

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In comparison, traditional financing for a business secured by issuing common shares or issuing debt would not be taxed, said Jamie Golombek, the managing director, tax & estate planning with CIBC Private Wealth Management in Toronto.

“They might have assumed that crowdfunding is similar to other types of financing in which you just go ahead and spend the money,” he said. “Where it is actually very different and the crowdfunding itself is the business income of the project or the company. It may certainly cause some plans to be revised.”

But it is consistent with CRA’s past policy, said Mr. Citrome, in which the money that comes in from a business is going to be subject to tax.

Joanna Griffiths, who raised $60,450 through an Indiegogo campaign in May and June this year to fund her Toronto-based high-tech lingerie line Knix Wear, said the ruling made sense and didn’t impact her business. Her company played it safe and claimed the amount raised from crowdfunding as income when their fiscal year ended in July, based on feedback from a tax lawyer, she said.

“In general, people should just have an understanding of what they’re getting themselves into with crowdfunding… They’ll have to really look and plan and think about whether it is worthwhile for them,” she said.

Craig Asano, executive director of the non-profit National Crowdfunding Association of Canada, welcomed the clarity.

“There were a lot of cases where entrepreneurs were trying to be clever as possible to bundle products in kind,” he said. “And that’s where it became tricky, because the entrepreneurs would say, ‘Well, we’re using this new vehicle to raise funds, however we’re giving gifts away.’ But tax agencies certainly see it as advancing their business model, and it should be deemed taxable.”

However, tax would only be paid if the venture generated profits and there was income to claim, said Mr. Citrome.

Still, for art projects, where some of the players involved are donating their time and operating on a shoe-string budget, it is somewhat disheartening have those contributions subject to tax, said Andrew Rosen, a producer for Aircraft Pictures.

Through Indiegogo, his company raised $123,160 to produce a short animated feature called “Todd and the Book of Pure Evil”, with the bulk of the contributions coming from interested fans, he said.

He said it is important to contribute a fair share of taxes and acknowledged that art projects also benefit from tax credits, but “to be taxed on the money that our fans are giving us, feels like an intrusion on a side project.”

However, the landscape for crowdfunding is changing, and those who contribute small amounts may soon be able to get a stake, in which case it would not be subject to tax.

The OSC and the Canadian Securities Administrator is in the process of reviewing exempt market regulations and whether to allow some kind of crowdfunding, such as where small contributions from a large number of investors are pooled in exchange for securities.

In the U.S., the JOBS legislation, which went into effect last month, allows accredited investors to buy small equity stakes in companies without the businesses going through the costly process of preparing a prospectus for a public listing.

Still, Kim McBrien, who raised $22,035 through an Indiegogo campaign this year to build a new studio for her yarn-making business Indigo Dragonfly, says the boost she got from crowdfunding went beyond the money itself.

She said she doesn’t expect the CRA ruling to be a hindrance, and crowdfunding has allowed her to expand her customer base, and get useful feedback.

“Even if we only got those benefits, it’s worth the price of admission,” she said.

This story was updated on Oct. 10, 2013 to reflect the following: Only accredited investors in the U.S. are allowed to make investments via crowdfunding, after the first stage of the JOBS legislation went into effect last month. A second stage of the law, which covers unaccredited investors, has not yet come into force.

Incorrect information appeared in a story in the Financial Post Thursday.

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